US stocks may face pain, buyers remain

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Reuters

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NEW YORK - Investors may crave a quiet market this coming week to digest the recent volatility in stocks and rehash Sunday's Super Bowl, but the prospect doesn't look likely.

The catalysts that drove the Dow and the S&P 500 to their worst monthly performances since May 2012 have not gone away. The retreat from emerging markets - and stocks in general - appears to have more room to run as the factors that helped propel the market to record highs in mid-January aren't providing enough support.

Calls for a market correction have become louder, with the S&P 500 down 3.6 percent from its all-time closing high and the Federal Reserve's announcement on Wednesday that it will keep trimming its monthly bond buying.

More than 80 S&P 500 components are set to report earnings next week, but the myriad issues surrounding emerging markets remain at the forefront for investors.

“Bad news in any area of the globe is bound to make sentiment less positive in others. This isn't an issue of contagion, but there will be influence,” said John Chisholm, chief investment officer of the Boston-based Acadian Asset Management, which has an emerging market equity fund with $1.2 billion in assets. “There's plenty more instability ahead.”

While countries such as Turkey and South Africa have taken steps to stabilize their currencies, the trend has remained negative for those assets.

The CBOE Volatility Index, a measure of investor anxiety, rose 34.2 percent during January to end the month at 18.41, after wrapping up 2013 at 13.72. The VIX remains below the long-term average of of 20, however, and has not traded above 19 since October.

For the month of January, the Dow fell 5.3 percent and the S&P 500 lost 3.6 percent - marking their worst monthly percentage declines since May 2012. The Nasdaq fell 1.7 percent in January, its worst month since October 2012.

It's tempting to believe that US stocks are a salve for this pain. But the reality is that when emerging markets swoon, US stocks decline as well, just not as much.

Goldman Sachs analysts wrote last week that when MSCI's emerging markets index falls at least 5 percent, the S&P 500 tends to fall by half of that. The MSCI index has dropped 11 percent since an October peak of 1,047.73.

“Our EM strategists believe some EM equity markets have further to fall, and that they require significant current account rebalancing before bottoming,” Goldman Sachs analysts said in a note about their outlook on emerging markets.

The effect on US companies is harder to discern. Goldman estimated that S&P 500 companies derive 5 percent of their profits from emerging markets, with some sectors more affected than others.

Among the companies with large emerging markets exposure set to report earnings next week are General Motors and Yum Brands Inc. Yum, in fact, gets more than half of its sales from the “BRIC” nations - Brazil, Russia, India and China. Yum's stock lost 11.2 percent in January, while GM shares dropped 11.7 percent.

Both stocks, along with the shares of other internationally exposed companies, have underperformed the S&P 500 since the Fed first said it would cut back on its stimulus on December 18.

Demand in China has been particularly sluggish, which affected Apple Inc's results, as the company's iPhone sales were worse than expected, and Wal-Mart Stores, which closed some locations in that country, as well as in Brazil.

Some are still looking to buy, though.

“We'd need to see more significant hits from overseas exposure before we start paring away our allocation to those names ... GM is doing well because of its EM exposure,” Acadian's Chisholm said.

With half of the S&P 500 companies having reported earnings so far, almost 70 percent have topped earnings expectations, above the long-term average of 63 percent, according to Thomson Reuters data. Two-thirds have exceeded estimates on revenue, above the historical average of 61 percent, though companies have generally been meeting or beating lowered expectations.

“While there are equity risks, there's very little risk from a bear market standpoint,” said Jim Dunigan, chief investment officer of PNC Wealth Management in Philadelphia. “That markets have held on as well as they have shows that equity appetite still exists.”

Whether there is conviction behind the buying is debatable. The three busiest days for the market in terms of the S&P's E-mini futures contract, the most heavily traded equity futures contract, were Wednesday, Monday, and last Friday, Jan. 24 - all of which were selloffs.

Still, investors keep pouring money into stock market funds, with $10.24 billion added in the week ended Jan. 29, according to Thomson Reuters' Lipper service. This marked the sixth straight week of net new cash.

The S&P 500 is about 0.5 percent above its 100-day moving average, a level that could provide support against further losses. According to the most recent Reuters poll of analysts, the benchmark index is expected to end the year at 1,925 - about 8 percent away from current levels.

Dunigan, who helps oversee $127 billion in assets, said that stocks remain “the best house in a bad neighborhood,” especially with US interest rates low.

“When you look at the alternatives, fixed income continues to look risky, and cash doesn't help you,” he said. “Unlike other asset classes, equities will still get boosts from contributions like buybacks, merger activity and capital expenditures.”

Reuters


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